JasonC

The Slow Start of Deflation: A Case for Bonds

The original writer is correct, bonds (not treasuries, corporates that actually have spread on them) will do quite well over the next 3-5 years. If you think treasury rates may move higher you can hedge part of the IR risk by being short T-note futures for about half the size of your long cash position in corporates. I would not try doing 1 to 1 as widening spreads can make the Ts outperform for short periods - but they aren't going to beat spreads this wide over the medium term.

Some of the financial preferreds are also interesting at these levels. You can get 8% on the soundest names, and 10% on moderate risk ones. The regional banks are up around 12% for credits that are objectively single A strength, which is an insane level of discrimination against the sector. If you have any fears about those, though, just use the better ones and settle for a 8-9% blended yield.

There are also a few floating rate preferreds which are interesting as a way to hedge interest rate risk, if you are unsure about the short rate outlook. Goldman preferreds can be bought today to yield over 6%, and will yield 140-150% of LIBOR if it rises, with a floor at the current rate. Those are a nice carry; the rate without any leverage isn't that interesting though.

For all of these ideas, sell if the spreads tighten up to 0.5% (or 0.75% more conservatively) again. Over a 3-5 year horizon that is likely - "this too shall pass". And it will involve double digit returns over that stretch, from the base rate plus the eventual re-tightening of spreads. With a lot lower risk than common stocks.